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Investment Analysis: Openwave Systems (OPWV)

November 23, 2010 | About:
Openwave Systems Inc. (Nasdaq: OPWV) is a global software innovator delivering context-aware mediation and messaging solutions that enable communication service providers and the broader ecosystem to create and deliver smarter services.

We selected Openwave because it is one of the select few that fits our model. Our goal is to select, purchase and continually monitor companies in an effort to obtain outstanding performing investments while minimizing risk by finding low values for our clients. We will cover part of our review and selection process as well as explain why Openwave has currently become one of our selections.

Introduction

Openwave has been seen as an innovator in the mobile digital revolution. They are creating a diversified product line, with solid quarterly execution. With their main Intergra platform product line, the Sprint browser applications and licensing revenues, they created additional strong probabilities of developing an ongoing successful business.

Openwave has a strong balance sheet, delivered a strong quarter and has the potential to be extremely well positioned in several desirable, basically monopolistic industries. If either of their two new products are successful, or their core continues to accelerate, they could attain higher bands of valuation. Currently, Openwave has a very low valuation for its enterprise value. Along with a strong quarter in sales and two new product segment introductions, they also competed the best booking quarter since the seasonally strong calender 4th quarter.

Step 1 – We first search for companies with pristine balance sheets.

Openwave has $117.5 million in cash meaning each share a cash value of $1.40. They have over $160 million in sales, with only a $55.5 million ($0.66 per share) enterprise value. This is an strong balance sheet and $0.66 per share is a very low value for an entire enterprise that is greatly increasing its strategic position in the software industry.

Step 2 – We like extremely low values.

Openwave is one of the lower valued companies that we have identified. The enterprise value per share is only $0.66. Sales last quarter were $41.5 million. The last 4 quarters (annual) of sales were $174 million giving Openwave a price to sales value of the enterprise of only $0.31 per share. Last quarter sales of $41.5 was just under the entire enterprise value of $55.5 million. These are extremely low valuations for a high margin software company.

Step 3 – Is the operation or enterprise driving value to their shareholders?

Openwave has three separate models of growth, two of which were introduced this past quarter. Individually, each could be consider a very high valuation models if successful. Properly executed over time, they could bring a superior benchmark valuation to their shareholders instead of their current depressed values.

Intergra

Openwave provided a very strong quarter. They are starting to see solid and improving traction in their Intergra media business line. They are making an effort of bring testing to their clients in an effort to provide them with hard proven facts that Openwave solutions could truly be beneficial.

They have 34 trials planed and/or completed with 50% of the trials by new prospective clients. Trials are periods where Openwave allows potential clients to utilize their products on a “try out” basis much like the local paper does by enticing customers to purchase a subscription with a free Sunday paper on occasion. Openwave projects they will achieve in the range of 25% to 33% close rate on their trial clients. They have already disclosed they have closed three Intregra media solutions with one already occurring this quarter.

Browser Application

Currently, we see this as a home run opportunity. The probability of them succeeding in this market is still considered a long shot. In our valuation modeling, adding a product with home run potential to the established core product line is significantly better than last quarter, when they browser application wasn’t a publicly disclosed concept. If Openwave could become the dominate software based application provider, while developing an application ecosystem utilizing numerous carriers, this could have the potential to be the home run. Companies that have achieved critical mass and leveraged a monopoly positions, have turned into great investments in most cases.

The browser application is based on the above Intergra platform, which Sprint (S) is using to deploy a new ecosystem of enhanced services within the Integra browser. This would make Sprint the first operator globally to announce a browser-based value-added ecosystem. Leading off with a company like Sprint and have an open based architecture allowing applications from many services to be utilized by open carriers, is nice for Openwave. This model provides higher revenues and controls along with additional benefits to the carrier or in this case the phone company. In the application world, Andriod has over an 100,000 application lead in this monopolist unit market. For Openwave, the biggest issues is gaining critical mass of both carries and applications. This will truly be challenging for a smaller company such as Openwave. Let us hope that all of the 27 Intregra platform clients (the last number disclosed) see the additional benefits of adding the browser application to their existing platform as a win-win and with an additional low cost revenue source.

The carries would love to have applications built into their software, where they would have control and coordination instead of being dictated in applications by a third party like Apple (AAPL) or Google (GOOG). Openwave and Sprint are selling the advantages of their newly combined ecosystem to both software application developers, and possibly more important, other carriers. If this ecosystem became robust, it could catapult Openwave into a monopolist business position possibly having the stock valued at the high end to its bench-marked peers.

Licencing Revenue

Like the Intrgra and browser application, the licencing segment showed solid execution this last quarter. Openwave has about 150 patents and they claim they have foundational patents for the entire mobile Internet. Many have credited Openwave with pioneering the Handheld Device Markup Language (HDML) along with creating the first working phone based browser. Openwave and their legal team believe their foundation position could cover ALL mobile Internet devices which is a very large and growing market, including possible components of successful products like Apple’s iPhone, Google’s Android and Research In Motion’s Blackberry. With that said, they have had only one proven licencing success with a small company (Mobixell/724) and one company does not produce a trend. If their patents prove to be foundational to the mobile internet, then just their patent portfolio alone could be valued many times larger than their entire current market capitulation.

They have about 10 years remaining on their foundational patents and the licensing market has been quite successfully for those who have executed well. We reviewed a little but highly profitable licensing company called Tessera (TSRA) just a little over 2 months ago and it is up about 40% since our recommendation.

Step 4 – Is this a good business?

This is a very valuable and possibly a monopolistic business model. There are very large barriers to entry albeit numerous global competitors. The ability to design, build and sell infrastructure software to the carries around the world in which their networks become dependant on those functions is a great business. There are few markets with the growth prospects and potential greater that what the wireless mobile market provide. The main issues is Openwave’s ability to execute and that ability has been flawed with past management.

Step 5 – Is the Train Wreck and then the fog from the Wreck clearing?

When finding companies with a negative or in this case low enterprise, often a “Train Wreck” is needed to drive value close to cash. We’ve identified three major issues that has kept the value so low:

1. Reliance on core vendors

2. Previous management

3 . Employees are using the stock option program as a cash machine.

Reliance on core vendors

Openwave has relied heavily on Sprint and AT&T as clients in recent quarters with each representing a large source of revenue in the past. The risk can be seen in last quarters results as AT&T declined to only 4% of revenues causing a negative material effect to earnings. With Sprint still representing 21% of revenues, any significant decline in sales to Sprint would be difficult to absorb. This appears to be the case with the AT&T decline.

Management

After having a revolving door at top management, Openwave has had a single recognized leader in Mr. Ken Denman, Chief Executive Officer, since November 2008. The business plan Mr. Denman has utilized was in place before he attained the CEO position and this quarter showed signs of real execution, increase product sales, pipeline and backlog. Our contacts from the firm say the working conditions at Openwave are significantly better than what they were in the past.

Some of the major mistakes that Openwave’s past management made were:

  1. They had a hostile takeover attempt that cause a out right fight for control and this caused an implosion of the ongoing business. With the new and established management working in sync with it’s shareholder, Openwave could possibly have similar success to another company that had a internal company issues that we follow. Since identifying and recommending on out Tollgrade (TLGD) review with a similar issue, the company is up about 25% since our August review. This helps to indicate that having share holders and management working together could help the returns for the stock.
  2. In January 2006, Openwave closed the $120 million acquisition of Musiwave, a French music application services provider for mobile phones. Less than two years later, Musiwave was sold to Microsft (MSFT) for $46 million. This single loss caused by the buy and sell of a division cost them more than Openwave’s current entire enterprise value.
  3. Due to the past real estate lease deals signed at the peak of the market, about $12 million in annual cash flow is being lost. These annual cost will terminate in 2013. This mistake by past management is costing the company shareholders about $0.14 a share annually. When these leases terminate, it will provide an additional 20% cash flow increase to the enterprise.


Employees stock options

Openwave still might have the worst stock option program that we have reviewed. They are diluting the shares by giving low priced options to employees. Yet the insiders with incentives, still only hold less than 1% of the entire company. If the employees, that are involved in the day-to-day management, have no interest in buying and retaining shares at significantly lower prices, then why does management believe investors should take the risk that management has divorced itself from?

Our Adams Resources (AE) review, found a company that has no share holder plan and has attained a whopping 50% insiders involvement, demonstrated a great return just after our published review. Why should share holders pay for a program that is providing a outright cost plus stock dilution, with no accountability or alignment with shareholders goals.

In Summary

We enjoy companies that can provide outstanding short term execution — turning weaknesses into real strengths, limited growth prospects into stronger multi positioned companies with possibly a superior business model driving their future success. We believe Opernwave has value, execution and a balance sheet that fits our our model, and we're optimistic that Opernwave will outperform their higher valued peers.

Valuation Ratios Company Industry S&P 500
Price to Sales 0.41 3.29 n/a

1. Revenue Base


Based on revenue models, knowing Openwave stock price is based with about 65% cash. The underlying enterprise value disparity between Openwave and their bench marked peers is materially significant. If you want to compare Openwave to its peers in sales values, assuming Openwave will achieve about $160 million in revenues, you get a per share value of $6.26 (their current run rate times the industry quoted peer, price to sales for the industry) — plus the $1.40 of cash, you get a combined value of $7.66. If Openwave executed on the newer higher monopoly or licensing models, the price to sale level would be possibly double the industry benchmarks.

2. Return on Buyout.

Since past buyouts have been able to strip out the cash, as occurred creating our very high return for DivX merger since our recent review, Openwave could be a target. Most technology companies are trying to enter the wireless mobility world due to the potential growth. Since the enterprise value of Openwave is so low, we believe it far more cost advantages to purchases an existing leading franchises then try to launch similar wireless software products platform. Since we have evidence of two possible buyouts in the past, and the very small management involvement in ownership. Openwave could possibly be a strong target form many firms.

We believe that Openwave enterprise is trading at about an 70% discount to many of its peers and well below most software companies in the wireless field. We find Openwave’s valuation surprisingly low, now especially with the belief that they have two additional revenue sources, each with the possibility of being a very large on their own. This coupled with the established solid business franchise, we find Openwave simply to be very undervalued at this time.

Disclosure

Durig Capital owns Openwave for itself, clients and related client accounts.



By Randy Durig CEO of Durig Capital

About the author:

Randy Durig
Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th-century Franciscan friar, William of Ockham. We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Please visit www.ockhamresearch.com for more information.

Visit Randy Durig's Website


Rating: 3.3/5 (6 votes)

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